Paul Fairbrother, manager of the UBS UK Select fund, has been selling mid and small-caps, and increasing his portfolio’s exposure to defensive stocks. He believes there are a number of reasons to be cautious about the outlook for equities after the rally since March 2003. He has been taking profits from stocks that have reached his assessment of intrinsic value, notably mid and small-caps in the media, support services and software sectors. “Since November we have been moving back to more defensive shares that have lagged the market rally,” says Fairbrother. “This has been reflected in the fund’s current overweight positions in beverages and tobacco, which display attractive relative valuations. “We like Diageo, Allied Domecq and Gallaher, and view all three as well-managed, highly cash-generative companies that have been overlooked in the recent rally. We are also continuing to find opportunities in smaller companies stocks, supported by our small-cap team led by Frank Manduca.” Fairbrother says he is cautious about whether the rate of return on UK equities, which reached 20.86% in 2003, is sustainable this year. He argues that stronger economic growth helped push up equity prices last year, but the raising of interest rates from 3.75% to 4% by the Monetary Policy Committee could mean growth rates will fail to match expectations in 2004. Furthermore, Fairbrother is wary about the long-standing problem of large US current account and budget deficits, and high levels of personal indebtedness among consumers. The final concern is caused by the optimism among fund managers about the prospects for stockmarkets this year. Fairbrother says: “Fund managers appear to be universally optimistic. The Merrill Lynch survey of fund manager sentiment shows that managers are as bullish about economic and earnings growth as they were in 1999. “We question to what degree market prices already reflect this optimism. In our opinion, many stocks are already fully valued.” According to UBS, the UK Select fund delivered a return of 24.89% in 2003, marginally outperforming the 20.86% gain in the FTSE All-Share.